Secured Loans

Type of Secured Loans

Secured loans are loans which require the borrower to pledge an asset or security to avail the loan. Home loans and car loans are the most common examples of secured loans where the borrower will be required to pledge the vehicle or house to be purchased as collateral, which then become secured debt. In case the borrower defaults on their loan repayment, the lender has full right to take possession of the collateral/secured debt. A secured loan is one of the best and assured sources of obtaining a high volume of funds.

There is a type of loan (under the category of secured loans) known as a non-recourse loan which protects the buyer. Under this loan, the bank has no further right to claim anything from the borrower apart from the asset pledged as collateral.

Foreclosure is the legal process by which banks auction/sell collateral property to pay off defaulted debt.

Repossession is when property (like a car) is taken back by the bank when payments on the same property are defaulted. This is for vehicle loans and loans for business assets. Example: If you buy a new car on loan and aren’t able to continue to make payments, the bank will come take your new car away, and you will forfeit all EMIs paid up to that date.

What is the purpose of having secured loans in the market?

When there are unsecured loans readily available, why would a person chose to take up a secured loan? There are two primary reasons, from the point of view of the lender and the customer.

Lenders are relieved of some of the potential financial burden and loss that they could incur as a result of default on payments.

Borrowers are eligible for higher loan amounts that are given on more favourable terms and lower interest rates as they have pledged an asset as collateral.

What are the types of secured loans, and the collateral required?

Most secured loans (home loans, car loans, business loans to purchase large assets) are sanctioned against a repossession clause, which should generally work for the benefit of the borrower, but more often than not, works in favour of the bank.

Features of secured loans

Loans are given against the title of ownership of assets, which will be used as collateral (like homes, vehicles, assets, property).

Lower interest rates as compared to unsecured loans, because the bank has a higher level of confidence in your ability to repay.

More flexible repayment options than regular loans.

Option of fixed rate and variable rate.

Loan approval is faster.

Customizable loans to cater to specific needs.

These loans are available to non-salaried individuals.

There is no need for a guarantor for these types of loans.

Banks and lenders can repossess assets for which loans were taken.

Improves CIBIL score once secured loan has been repaid in full. More favourable than unsecured loans.

Eligibility criteria

You must meet the following requirements to be eligible for a secured loan:

Applicants must have reached the age of 18 years or older.

Applicant must be a resident of India.

Most banks and lenders require the applicant to have a minimum annual income of Rs.3 lakh per annum.

Income can be generated from regular salary, non-salaried income and business income.

For loans based on business income, the business must have been running and generating a profit for the last 3 years.

Applicant must have assets, whose value must match or exceed value of loan required.

Documents required

You will, of course, need to submit a bunch of documents to the lender or bank, so that they can establish your identity, address, and other details. Documents you will require for different kinds of secured loans are:

Mortgage loan:

Proof of identity – This should be an official document which contains your name and photograph. Could be either your driving license, passport, voter’s ID, PAN card, Employee ID (if the company is registered), etc.

Proof of age – Should be a verifiable document that determines your age, such as a birth certificate, passport, voter’s ID, etc.

Proof of income – This should be an official / certified document which contains the details of your income and tax paid (TDS). Could be either your salary slips for the past 3 months, or Form 16 duly filled in and attached to a salary certificate.

Proof of residence – This should also be a certified document that verifies your residential address in the eyes of the law. Could be either your phone / internet bill, rental agreement, bank account statement, etc.

Original property documents of the property that is being pledged as collateral against the loan.

Proof of age – Should be a verifiable document that determines your age, such as a birth certificate, passport, voter’s ID, etc.

Duly filled in application form. This is available from the bank itself.

Proof of identity – This should be an official document which contains your name and photograph. Could be either your driving license, passport, voter’s ID, PAN card, Employee ID (if the company is registered), etc.

Passport sized and stamp sized photographs.

Proof of income – An official / certified document which contains the details of your income and tax paid (TDS). Could be either your salary slips for the past 3 months, or Form 16 duly filled in and attached to a salary certificate.

Bank statements for the last 6 months.

Verified proof of signature. The lender will require many specimen signatures, verifiable against certified documents that already contain your signature.

Proof of residence – A certified document that verifies your residential address in the eyes of the law. Could be either your phone / internet bill, rental agreement, bank account statement.

Proof of residence – A certified document that verifies your residential address in the eyes of the law. Could be either your phone / internet bill, rental agreement, bank account statement.

Proof of identity – This should be an official document which contains your name and photograph. Could be either your driving license, passport, voter’s ID, PAN card, Employee ID (if the company is registered), etc.

Bank statements for the last 6 months.

Guarantor (optional).

Business loan:

Company profile and product range – a description of your company, the products or services it exchanges for money, its managers and functions.

Promoter profile.

Audited balance sheets for the last 3 years.

Proof of residence – A certified document that verifies your residential address in the eyes of the law. Could be either your phone / internet bill, rental agreement, bank account statement.

Proof of identity – This should be an official document which contains your name and photograph. Could be either your driving license, passport, voter’s ID, PAN card, Employee ID (if the company is registered), etc.

Benefits of secured loans

Secured loans have many benefits that don’t apply for other types of loans. Secured loans can get you:

Lower interest rates because the bank can rely on your desire to keep your collateral. Banks will lend with lower interest rates if they know their investment in you is protected. This of course means easier payments and a lower eventual hit to your personal finances.

Larger loan amounts are sanctioned, as the bank’s liability and risk is substantially reduced. The bank will approve loan amounts that are as close to the value of your collateral asset as possible, and not make room for their potential loss.

Better terms and conditions from the bank. Easier and cheaper processing (sometimes free), faster documentation and approval, and overall friendlier terms that don’t leave you in the lurch in case something goes awry.

Flexible repayment terms, mean that you don’t have to worry about fines and charges on settlement payments, pre-closing your loan, making one big payment that greatly reduces your capital (if you’ve suddenly come into some money), or if you want to close your loan early or even if you want to extend your loan tenure. Some banks and lenders don’t allow you to close your loan early, but with secured loans, this is possible.

Flexible repayment tenure, customizable to suit your ability to repay. You can choose to repay your loan faster, with chunkier EMIs for a shorter period, or choose to pay smaller amounts over a longer period. The choice is yours, for as long as your collateral asset is yours.

Can be availed by those who have a bad credit history or CIBIL score - as both these indicators are basically representative of your ability to repay your loan. When you add a collateral asset into the equation, the need for the bank to know whether you can or can’t pay back your loan becomes irrelevant. The reason they need CIBIL and credit history information is to assess their own level of risk, but with an asset on the line, they undertake minimal risk.

Interest is tax deductible, thus saving you more money that would otherwise be lost to taxation.

Minimum income required is far lesser than that for Unsecured Loans, as this is also an indicator of your ability to repay. Your ability to repay is a factor that becomes moot, as you have already pretty much paid them by pledging an asset as collateral.

Disadvantages of secured loans

Along with the advantages that secured loans bring, there are also many disadvantages, like:

Collateral seizing – The bank, while it approves a higher loan amount and a lower rate of interest, will not hesitate to seize all assets you have pledged as collateral. You must be as ready to give up the pledged asset as you are to take the loan. You must be ready to lose the roof over your head, the car in which you travel and the assets that earn your keep.

Repossession – If you’re purchasing, say, a vehicle with a secured loan, you will be placing the vehicle as collateral against the possibility of your defaulting on the loan. This means that if you miss a payment or default in any way, the bank will take back your new vehicle and all EMIs that you’ve paid thus far will be considered null and void. You will lose all the money you’ve paid towards your new vehicle (plus interest), and the vehicle itself, leaving you totally stranded and completely broke. Let’s face it, if you had the funds, you would’ve repaid your loan.

Heavy paperwork – Secured loans require a lot of paperwork, as you will have to provide the regular documents required (identity, age and address proof) along with documents that relate to the ownership of your asset. You will also be required to affix a metric ton of specimen signatures to a series of documents, and if even one of these signatures does not match the others, you will have to go through the entire arduous process again.

Full ownership of collateral asset – If you wish to pledge an asset against a loan, you will have to be the full owner of that asset. The asset will have to be cleared of all EMIs and partnership agreements and will have to be solely owned by the person who is applying for the loan.

Longer time period = greater total cost – A longer time to pay off the loan allows for more potential hiccups in your general rate of income, even the slightest dip in which could affect your repayment schedule. And if you miss an EMI payment, the bank will levy heavy fines and penalties which will compound and result in you losing your asset. A longer repayment schedule also means a larger eventual total cost, despite smaller monthly payments.

Value of asset must match or exceed loan amount – the loan you desire must be recoverable by the sale of the asset you are planning on pledging. If the bank cannot realize its loss through the sale of the collateral, it will come after you with a legal document called a deficiency judgement, which will bind you to fulfil your liability.

Living in debt – if you are unable to clear the loan even after the bank has seized your assets, you will be doomed to a life where any income you generate will go straight to the bank. More often than not, you will be paying off interest charges and penalty charges and the principal amount will remain more or less the same. Can you imagine a life where the bank has taken the roof over your head and you’re still paying them off?

CIBIL score – you CIBIL score will suffer greatly if you default on a secured loan repayment. If the bank has to seize your house and other assets, your score and rating could go to a place from where it is very difficult to recover.

Secured loans are a way to secure finance in times of dire need, but must be used very cautiously and not at all be taken lightly. The asset pledged as collateral must be considered as property of the bank in the mind of the borrower, until the loan is repaid in full. Banks will not hesitate or think twice before seizing a defaulter’s collateral, and almost seem like sharks circling a boat waiting for someone to fall off of it.

If you are confident and able to repay your loan on time, every time, the interest rates, repayment schedules, terms and conditions are unmatched by those of any unsecured loan.

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